What is ROI? A Guide to Return on Investment

Return on Investment (ROI)

ROI is a financial metric used to calculate the probability of gaining a return from an investment. It measures the amount of return on an investment relative to the investment's cost.

How to Calculate ROI

The simplest formula for ROI is:

ROI = (Net Profit / Cost of Investment) × 100

Where:

• Net Profit = Current Value of Investment - Cost of Investment

Example

If you buy $1,000 worth of stocks and sell them a year later for $1,200:

1. Net Profit = $1,200 - $1,000 = $200
2. ROI = ($200 / $1,000) × 100 = 20%

Why ROI Metrics Matter

• Comparison: It allows you to compare the efficiency of different investments.
• Simplicity: It's easy to calculate and understand.
• Versatility: Can be applied to stocks, real estate, business projects, and marketing campaigns.

Limitations

• Time Factor: Basic ROI doesn't account for the holding period (e.g., a 20% return over 1 year is great; over 10 years, it's poor). For that, you might need Annualized ROI.
• Risk: It doesn't factor in the risk associated with the investment.